A ‘weaker hand’

The Canada dollar has a lot riding on NAFTA as Ottawa returns to the bargaining table in a “near-take-it-or-leave-it” squeeze.

Like the peso, the loonie jumped Monday as the U.S. and Mexico struck a deal, putting the heat on Ottawa, particularly given President Donald Trump’s renewed threats to hit Canada with tariffs on auto imports should there be no resolution on the North American free-trade agreement.

As The Globe and Mail’s Adrian Morrow and Robert Fife report, Foreign Minister Chrystia Freeland will be back at the table in Washington today.

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“Canada now appears to be in a near-take-it-or-leave-it situation with respect to spinning the U.S.-Mexico deal into a broader agreement on a revamped NAFTA,” said Bank of Montreal senior economist Robert Kavcic.

“Should the circumstances dictate that they ‘leave it,’ (Mexico is still openly hoping for Canadian participation), a possible 25-per-cent tariff on auto production looms, as threatened again by President Trump,” he added in a report.

“But, the fact that a number of Republicans in Congress have expressed the need to keep Canada in any deal could be a chip in Canada’s favour. Indeed, should the U.S. and Mexico be relegated to a bilateral deal, the ability to push it into law is unclear, and likely won’t be nearly as swift.”

Bipan Rai, North America head of foreign exchange strategy at CIBC World Markets, agreed Ms. Freeland is returning to talks with “a weaker hand.”

Canada is still at risk of being “left out in the cold,” Mr. Rai said, which would, of course, ding the loonie.

“That risk increases substantially if the Trudeau government digs in and decides that the new agreement does not suit them,” he said, adding that Ottawa will have to give in on some issues to get a deal.

“If Canada is left out – that’s CAD bearish. Full stop,” Mr. Rai said, referring to the loonie by its symbol.

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“No deal implies that we’re looking at a scenario where auto tariffs from the U.S. come into play and domestic investment is likely to slow. At the very least, that pushes out Bank of Canada rate hikes to a degree.”

Having said that, CIBC, like others, believes a deal with Canada will be struck, even though no one knows what it could look like.

“The deal or no-deal play is what matters for Canada and the CAD this week,” Mr. Rai said.

“Markets are already pricing a deal, so the risk has become asymmetric towards a no-deal scenario. If you’re concerned about the CAD – keep that in mind and worry about the details later.”

Benjamin Reitzes, BMO’s Canadian rates and macro strategist, forecasts that the currency will “appreciate modestly” this year to just shy of 78.5 U.S. cents, and more in 2019 to the 80-mark should Ottawa join the U.S. and Mexico in a new agreement.

This comes, too, at an interesting time for the Bank of Canada, which meets next week and had been expected to hold its benchmark rate steady until October.

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Governor Stephen Poloz and his central bank colleagues have oft cited the uncertainty surrounding NAFTA, but have also said they’re waiting for something concrete.

“Until there is a more definitive result on NAFTA, expect the status quo from the BoC on policy,” Mr. Reitzes said, and, thus, he still expects the central bank to hold the line next week.

“Note that even if Canada joins the agreement, it’s unclear the BoC will get more aggressive on policy, though it likely would ultimately mean that interest rates finish the cycle higher than if there is no NAFTA resolution,” he added.

A comment I’d love to hear

What the analysts say

“Canada lacks leverage in the negotiations, owing to the asymmetries in the trading relationship between the U.S. and Canada. Trump’s threat of auto tariffs also raises the pressure on Canada to accept the terms of the deal on offer. Whether or not Canada agrees with the concept of a NAFTA reboot, we suspect it does little to benefit the loonie. An in-principal agreement is worth a knee-jerk in the headlines, though it is unlikely to offer much momentum beyond that. Indeed, we estimate zero to little risk premium priced into the currency, suggesting there is not much of a discount to price out.” Mark McCormick, TD Securities, in a report titled “Canada, you’re fired”

“The Canadian dollar is seeing a short squeeze of significant fashion as the bears cover – seemingly in anticipation of a successful resolution to NAFTA, or whatever its new acronym will be going forward.” David Rosenberg, Gluskin Sheff + Associates

“Canada may find it harder to sign up to US-Mexico understandings on other key U.S. demands - but the pressure for Canada to get on board quickly may also hand it more leverage … [The] announcement should substantially lighten market-pricing of NAFTA risk for all three countries, but a great deal of work remains to be done to conclude a new trilateral NAFTA 2.0. Nevertheless, [it] event provides the White House with a strong talking point ahead of the mid-term election: President Trump doesn’t need a signed and sealed new NAFTA to campaign on his ‘success’ in renegotiating the trade agreement.” Brett House, Derek Holt, Eduardo Suarez, Bank of Nova Scotia

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“Depending on what the U.S. now asks of Canada, the Mexico-U.S. agreement on autos is a potentially positive development for Canada, since Mexico had been securing the lion’s share of recent new investments in the North American auto industry. However, we still openly wonder whether this is a net positive for Canada as things stand right now - it is not yet obvious that a deal agreeable to Ottawa can be reached, and the president’s tone [Mondy] was far from encouraging on that front. In other words, while we are cautiously optimistic, we would not change any Canadian forecasts until Canada is officially part of the deal - or isn’t, as the case may be.” Douglas Porter, BMO

“The trade deal needs to be approved by Congress, but investors are clearly confident of it getting approved. Trade tensions have been hanging over equity markets, and this is certainly a step in the right direction. It is believed that Canada will be on the agenda next, and traders will be paying close attention to those developments.” David Madden, CMC Markets

“Both sides hailed the agreement, and it provided some hope that at least one major link of the global trade chain might survive damage. Still, many obstacles remain, including whether Canada will accept the changes and join the revised pact, and how the White House will shepherd a bilateral agreement through Congress if Canada opts out.” Société Générale

“[Trump] wants to actually drop the name NAFTA and call it a bilateral U.S.-Mexico deal, with negotiations set to start immediately with Canada. That underscores our view that Canada is going to be presented with more of a take-it-or-leave-it offer, with the now not so subtle threat that the U.S. is prepared to leave Canada out and work on a bilateral basis with Mexico. For their part, the Mexicans are signalling their interest in staying with a trilateral pact involving Canada. We still think Canada and the U.S. will come to the table and get a deal done, but by saying Canada could be left out, the U.S. is threatening to take a tough line in those talks. Avery Shenfeld, CIBC

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